Spot unethical sales practices

By Ginger Applegarth

The old saying is that people don't buy life insurance, it's sold. That's not really true, since most people really do need life insurance to protect the security of their loved ones. But it's the type of life insurance and how much you buy where the adage rings true. In this article, we'll discuss some of the things to watch out for when working with insurance agents. Understand that most insurance agents are helpful and professional. This article focuses on the minority.

It turns out that consumers had very good reason to fear some agents and some companies in the 1980s and early '90s because of rampant fraud and abuse. But now it's the insurance companies who are running scared; the tables have turned.

Life insurance as an investment

In the late 1970s, insurance regulatory changes and high interest rates made companies develop new "investment-related" products such as universal life insurance. Agents started to sell life insurance as an investment. Policyholders began to consider permanent life insurance products as part of their investment portfolios.

Additionally, the advent of computer software led some companies to aggressively distribute insurance illustration software, assuming interest rates of up to 13% or 14% throughout the policy's life. Other companies figured out a way to override the maximum assumed interest rate and plug in their own numbers of as much as 19%. If the software would not allow this override, the agent would pay to have a simple spreadsheet program of his own developed for use in marketing permanent life insurance policies.

The 'vanishing' premium

With these assumed high interest rates, the projections showed that the premiums would "vanish" in as little as four or five years. Normally premiums vanish because the dividends (if it's a whole life policy) or interest (in the case of universal life) are enough to keep the policy in force by paying the premiums from the cash buildup. This is especially true for universal life insurance, because unlike whole life insurance (which has a fixed premium), a person could pay less than the recommended premium -- sometimes even skipping a year. But what really happened was disastrous: As actual interest rates dropped, premiums did not vanish, but continued upward for another decade or longer.

Even worse, some policyholders found that their vanishing premiums suddenly "reappeared," and, in some cases, they were unable to pay them. Many agents aggressively marketed this vanishing premium (or "premium offset") method of paying for insurance. There is nothing wrong with the vanishing premium concept, provided that a reasonable interest rate of 6% to 8% is used in the illustration as the assumed dividend rate. Under this analysis, the premium might vanish after 15 years or so.

Churned policies

Additionally, some agents "churned" policies. This means they persuaded policyholders with old life insurance policies containing large cash values to buy replacement policies, thereby earning the agent hefty commissions on the new sales. These new policies usually had a much higher death benefit, and the sales illustrations (using unrealistically high interest-rate assumptions) would show little or no additional premium payments required, because the cash values from the old policies were supposed to be enough to fully fund the new ones.

It looked like a great deal to the policyholders -- higher death benefits with little or no out-of-pocket expense -- but those new commissions and other new policy expenses took a big bite out of the built-up cash values, and of course interest rates dropped. The result? Many policyholders were faced with unexpected premium payments just to keep the policies in force. They had to pay up -- and keep on paying -- or let the policies lapse and lose the death benefit altogether.

The churning system has taken on a new tack recently. Consumers have now complained of agents that convinced them to buy whole life insurance policies, which rewarded the agents with fat commissions. But after a few years, the commissions dwindled. So what did these agents do? They convinced their customers to borrow money from their policies in order to purchase variable life annuities. Now, annuities do offer a guaranteed income stream in your later years, but borrowing money from another policy is horrible money management. You will not come out ahead financially.

Lessons learned

The good news that comes out of issues like this is that it reinvigorates the rest of the industry to sell in a more ethical manner and it forces life insurance companies to supervise and train their agents better.

Supervision is the key, as companies must take responsibility for what individual agents shows prospective policyholders. Many companies now require that the sales illustrations be attached to the policy application.

Most of us do need life insurance of some kind and a good life insurance agent can be as important as a good financial planner. Some of the older life insurance companies have been around for more than a hundred years, and most sell insurance for what it is --protection against death, with a savings account built in (if you buy permanent insurance with cash values building up).